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Interesting Facts
UK Inheritance Tax Issues
Irish Resident and Domiciled
Individuals Bequeathing UK Assets
Consider the fictitious case of Tom and Sarah, who are Irish
resident and domiciled. They have UK assets, comprising
stocks and shares, valued at £200,000 and £250,000
respectively. They have each made a Will, leaving everything
to each other absolutely, with everything passing to their
children on the death of the survivor. Neither has made
lifetime gifts of UK assets. What are the potential tax
issues and is there an optimum way of structuring the inheritances
in order to minimise the liability to tax?
A UK-domiciled transferor is liable to UK Inheritance Tax
(IHT) on his/her worldwide estate. A non-UK domiciled transferor
is liable to IHT on the UK-situated assets only.
Irish Capital Acquisitions Tax (CAT) is a tax on acquisitions
(beneficiary’s tax). UK IHT is a tax on transfers
of capital (donor’s tax).On a death, the net value
of the estate for IHT purposes is its net value after deduction
of the debts and other liabilities of the deceased. No deduction
can be made for administration expenses or other post-death
liabilities.
In order to determine the relevant tax due, it is necessary
to determine what transfers made by the transferor are 'chargeable
transfers' and what are 'potentially exempt transfers' and
'exempt transfers'.
A chargeable transfer is a transfer which is neither a potentially
exempt transfer (PET) nor an exempt transfer. A PET is a
transfer by a transferor to another individual or specified
trusts as mentioned in the UK Inheritance Tax Act ( IHT
Act) 1984. When it is made, a PET is potentially exempt
from IHT and it remains so for 7 years. It becomes unconditionally
exempt if the transferor survives the date of the gift by
7 years. If he does not survive the 7 years, then that gift
becomes a chargeable transfer.
If the transferor dies more than 3 years, but less than
7 years, after the transfer was made, tapering relief applies
to reduce the amount of tax on the now chargeable PET. The
relief is as follows:
Years
before death |
% of tax at time of death rate |
3-4 |
80% |
4-5 |
60% |
5-6 |
40% |
6-7 |
20% |
The legislation further allows for 'exempt' transfers in
certain specified cases to include transfers between spouses.
(If the transferor is UK-domiciled and the spouse is not,
then the spousal exemption is £55,000.). It also includes
small gifts exemption up to £250,00 and gifts in contemplation
of marriage.
IHT on a chargeable transfer is calculated cumulatively
by reference to the total chargeable transfers made within
7 years of that transfer. There is no tax on the first part
of the cumulative total (similarly to Irish CAT with the
tax-free thresholds), known as the 'nil rate band'. This
increases each year in accordance with the UK Retail Prices
Index (RPI) unless 'Parliament otherwise determines'. The
nil rate band for 2005 is £275,000. The Finance Act
2005 has already enacted that the nil rate band will be
£285,000 in 2006-07 and £300,000 in 2007-08.
The UK tax year is the year commencing on the 6th April.
(This is unlike the Irish tax year, which is the1st January
to 31st December.)
For transfers on death (or within 7 years of death), the
rate of tax on the amount above the nil rate band is 40%
and is referred to as the 'death rate'. When a lifetime
transfer is immediately chargeable, the rate of tax is half
the death rate, i.e. 20% (referred to as the 'lifetime rate').
Before considering the ways of avoiding or minimising IHT,
it is necessary to consider the rules governing the situs
(location) of assets. Land and immovable property are determined
by their location, i.e. whichever country they are situated
in. Shares and securities are determined by the country
of the Register, i.e. where entry on that register is necessary
to record ownership. Chattels, such as furniture, art works
and cash, are situated in the country in which they are
physically present.
In the case of Tom and Sarah cited above, there are two
scenarios that need to be addressed:
- IHT on first death: If Tom dies
first, Sarah will inherit his entire UK estate free of
IHT due to the spousal exemption.
- IHT on second death: On the death
of Sarah (ignoring any increase in the value of her estate
or changes to the nil rate band), her estate will consist
of her original £250,000 plus the £300,000
inherited from Tom. This will be taxed as follows:
Value of Sarah’s estate
£450,000
Less: nil rate band £275,000
Amount liable to IHT £175,000
IHT on £175,000 at 40% will
be £70,000.
However, with prudent tax planning, this liability could
have been avoided. If Tom had left his UK assets to his
children, they would have inherited them free of IHT since
the value of his estate (£200,000) was within the
nil rate band. On Sarah’s death, her children would
inherit another £250,000 from her free of tax since,
once again, it is within the nil rate band.
Utilising the nil rate band effectively ensures that both
the spouses have a maximum amount of assets (to the value
of the nil rate band) in each other’s estate.
Comment
In most cases, married couples have properties in joint
names, which means on death, the properties will pass automatically
to them by survivorship. In such circumstances, spouses
should consider transferring some of the assets to their
sole names so as to be able to utilise the nil rate band
in each estate.
Due to the increased economic and financial growth in Ireland,
there has been an increased amount of cross-border investments.
These carry with them different tax and legal consequences.
As shown above, they will vary in accordance with the residence
and domicile of those making the investments and the location
of such investments. It is therefore imperative to seek
the advice of a tax consultant when considering transferring
assets to the next generation.
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